XXX-Ratings May Save Us From Financial Armageddon: William Pesek

Nov. 30 (Bloomberg) -- Twelve-hour flights are a chance to
catch movies you might not expect to be good entertainment --
such as “Too Big to Fail,” Hollywood’s take on the meltdown of
Lehman Brothers Holdings Inc.

I watched it while flying from Tokyo to New York and kept
thinking about what Lehman’s failure says about the Olympus
Corp. scandal back in Japan. The off-balance-sheet risks, the
tax havens, the impenetrable accounting, the smarmy and
delusional executives saying all’s well, the hapless regulators.

Then it hit me. The world of finance should become more
like the movies, with a rating system that actually makes sense.

In Japan, the public obsession is with whether Olympus
executives will get jail time, or whether a corporate icon will
be delisted. The real story, though, is how the business of
finance gets done in the age of globalization.

For all the talk about transparency and the magic of
markets, finance still thrives on opacity and public relations.
It’s an art form with a small army of bankers, accountants and
advisers moving complex, Dali-esque deals around the globe
faster than even they can follow. It’s not just that the average
investor can’t make sense of these transactions; they aren’t
supposed to.

Rather than wasting taxpayer money on investigations and
new red tape, why don’t regulators convert themselves into
ratings companies? If the movies can red-flag objectionable or
risky material with its “XXX” and “R” ratings, our financial
regulators can, too. Let’s face it, with XXX you know what
you’re going to get.

XXX Warning System

Let’s start with an XXX warning label on any company
incorporated by way of a post-office box in the Cayman Islands,
British Virgin Islands, Cook Islands, Jersey or any other kiss-and-don’t-tell jurisdiction. The message would be if you invest
in this outfit, you may have no idea what this company is up to
and you might lose your shirt.

If pension fund managers invest mom’s life savings in
companies with XXX ratings without shareholders knowing, they go
to jail. No exceptions. Instead, they would have incentives to
invest in AAA shops (those safe for grandma) that make no use of
offshore counterparties where it’s impossible to trace
beneficiaries and that are fully compliant with U.S., U.K. or
other regulations and tax codes.

Ratings as far away from XXX as possible would enjoy a
sizable valuation premium. Not only would it scare up mountains
of missing tax revenue that sovereign-debt issuers so
desperately need, but it would make markets safer.

Star Power

Come on, can anyone really say our global credit-rating
system works? Look no further than Standard & Poor’s downgrade
of U.S. debt this year. Afterward, investors couldn’t get enough
dollar-denominated securities. Then there’s MF Global Holdings
Ltd., which S&P, Moody’s and Fitch Ratings all rated investment
grade a week before bankruptcy. Congress is right to investigate
whether Jon Corzine’s star power and political connections
clouded judgments of the New York-based firm’s viability.

Recent events say much about the way markets continue to
operate more than three years after Lehman blew up. Any system
that allows debt issuers to shop around for the best rating is
destined to be corrupt.

There’s lots of money to be made from slapping the desired
rating on this mortgage-backed security or that sovereign
credit. The combination of greed and creative analysis makes it
hard to know what is legal and illegal in an increasingly global
world.

Financial Cliff

Our credit-rating system also shows how little things have
changed. It missed the Asian crisis 14 years ago and Russia’s
default a year later. It was asleep on the job when technology
stocks crashed, Enron Corp. imploded, the U.S. housing bubble
inflated, Wall Street lost all sense of responsibility and
Europe veered toward a financial cliff.

So, really, when credit raters raise China’s sovereign
rating or bump Citigroup Inc. up a notch, it might be a sign to
sell and brace for trouble. If 2008 taught us anything it’s that
regulators are a few years behind the financial alchemists.

Had movie ratings for businesses been in place, we might
have been deprived of the terrific scene in “Too Big to Fail”
showing former Lehman Chairman Richard Fuld trying to sucker
Korea Development Bank into buying his train wreck of a firm.
Korean officials, very wisely as it turned out, sensed they were
being played. Fuld, portrayed by the brilliant James Woods,
quickly gets on the phone to find an easier mark.

We have seen this picture before, and a sequel may be in
the works for 2012. We know how the first installment turned
out. Regulators can and should protect investors and entire
economies on the front end. If Hollywood can do it, the
overseers of Wall Street can, too.

(William Pesek is a Bloomberg View columnist. The opinions
expressed are his own.)